Econ 101: Government Interventions – Part Two

In the last article, I was discussing the idea that taxation causes the economy to be less efficient as people are prevented from using their money only for goods or services which they value and instead are forced to use it for services which some of them won’t value. Another aspect of this inefficiency, however, is built-in to the government-provided services themselves. There are two facets of this built-in inefficiency: the inability to gauge customer satisfaction and what might be termed a disincentive to economize.

In a free market, companies have to provide their customers with a satisfying experience or risk losing those customers to a competitor. When enough customers take their business elsewhere, the company will lose money. The easiest way for a company to know that it is satisfying its customers is the fact that it’s making a profit. Profits tell a company that it is running efficiently and making its customers happy. Losses tell a company that it is not running efficiently and/or that its potential customers are not happy.

Government has no “profit-and-loss test” like this. For the most part, it faces no competition for the services it provides. Furthermore, all government services are either paid for entirely by money collected in taxes, or else, in the cases where users pay fees, it is understood that tax money will be used to bail out departments that are losing money. Therefore, the government cannot know whether and to what extent it is providing a service that is valued, and it cannot tell whether and to what extent it is providing that service efficiently and in a way that is satisfying its customers.

Another facet of this inefficiency has to do with incentives. In a private company that depends on making a profit to stay in business, cost-cutting is typically encouraged and rewarded. In government bureaucracies, because there’s no profit and loss test to tell if a department is running efficiently, each department’s budget is based on what they spent the year before. If there is any money left over at the end of one year, it is assumed that they don’t need as much the next, and so their budget may be cut. If the department spends its entire budget for the year, it is easier for the manager to justify receiving the same amount or more for the next year. This disincentive results in a tendency for government to continually spend more and more.

Note that these problems exist independently of whether a given department or agency is making any progress at all towards its mission. No matter how bloated or ineffective a government department already is, the government has no way to make it more efficient and no financial incentive to do so. In part three, I’ll take a look at ways that government, besides being inefficient in and of itself, actually hinders the free market from being as efficient as it could be.